The Stock Bubble In Context (Will The Last Bear Please Turn Out The Lights?)

by Wolf Richter • Nov 25, 2013 • Comments Off on The Stock Bubble In Context (Will The Last Bear Please Turn Out The Lights?) • Email to a friend

Bubbles don’t happen in a vacuum, but in a context. Which is this: 47.6 million Americans receive food stamps, almost triple the 17.2 million in 2000 when the dotcom bubble blew up. The Los Angeles Regional Food Bank, which distributes 1.1 million pounds of food a week, mostly to food pantries, said that the number of people seeking assistance has jumped 50% since the Great Recession.

“People are just trying to hold on to their housing, rent, utilities, and other fixed expenses,” CEO Michael Flood told the California Report. “And whatever is left over in the budget is their food budget, and that’s where they run short.”

In the last jobs report, the all-important employment-population ratio – the number of people working as a percent of the working-age population, the least manipulated indicator – dropped to 58.3%, just one notch above the low of 58.2% in June and July 2011, last seen in the early 1980s. It means that the jobs created since the Great Recession, however crummy they may be, have merely kept up with the growth of the working-age population. The goal of “full employment” has become illusory.

There was full employment in 1999 when the employment-population ratio topped 64% (to peak in April 2000 at 64.7%). This was also when the real-wage peak occurred. But the hot air had started to hiss out of the stock market bubble, and employment would never be the same.

This is one side of the economy the Fed has concocted with its ZIRP and QE that it’s so proud of, and that future Chairwoman Janet Yellen has defended so eloquently during the Senate hearings – though she should have been skewered for them.

The other side of the economy looks better: soaring asset prices. Farmland, housing, art, junk bonds, even sovereign junk bonds, more palatable bonds, stocks… irrespective of the underlying economic conditions.

Hence, bubble talk. That’s exactly how it happened in 1999. At first, a few people were talking and writing about the bubble, describing it, outlining its irrationality. They were ignored, then pounced on by a horde of pundits who considered them demented fear mongers. The pundits then invented metrics to show why these stocks were actually worth that much, nay, twice that much.

As the markets continued to skyrocket 1999, more and more people were talking and writing about the bubble. The Fed denied its existence. CNBC belittled the idea. Wall Street came up with new metrics. But everyone in the market worth his or her salt knew it was a bubble. All they wanted was ride it up to the top and then get out, and they raked it in, with their curser never further than a quarter inch from the sell button. Alas, there were plenty of false alarms when they clicked that sell button only to chase the same stocks higher a little later.

And finally, people were writing and talking about how everyone was writing and talking about the bubble, how bubble talk has become a bubble itself, and pundits cited the fact that so many people were writing and talking about the bubble as a reason why, by definition, the bubble could not exist. This happened in 1999. And this where we are today.

Last week, CNBC found that Google searches in the US in November for the term “stock bubble” was the highest since 2007 just before the last bubble blew up. Unfortunately, search data only goes back to 2004, so there is no comparison to 1999. CNBC managed to twist this into a bullish signal. “That means, conclusively, that there is no stock bubble,” it quoted Jim Iuorio of TJM Institutional Services as saying. The fact that this sort of thing shows up on CNBC is sign of a bubble.

Everybody loves bubbles.

Governments love them because tax revenues balloon as people sell one overpriced asset to buy another and pay taxes on huge but ephemeral gains, and as brokers and banks and other Wall Street players siphon off fees and make fat profits, some of which they can’t shelter from taxes. Bubble rain manna on every level of government.

The financial media love them because they make them feel relevant. Traders love them because bubbles make them feel smart. Companies love them because they can print money by issuing overpriced stock to buy other overpriced companies and enrich executives. The Fed loves them because bubbles show it can actually do something other than creating inflation and devaluing the dollar. All of these entities routinely deny the existence of a bubble.

Though nearly everyone saw the bubble in 1999, it was hard to tell when it would be over, and the money was too good and too easy to not participate. Burned by too many false alarms, investors were still buying on the dip or hanging on to their portfolios, hoping for the best, even as the hot air was hissing out of the bubble, destroying their wealth, the gains they’d already paid taxes on, and their idea of how they’d retire. Same in 2007. It’s easy to see a bubble. It’s harder than heck to see when it ends.

But a stock bubble cannot deflate until after retail investors have poured their money into it – the purpose of a bubble being redistribution of wealth from latecomers who put their hard-earned life savings at risk to early investors with access to the Fed’s free money. Stocks are a zero-sum game. Every share bought by a late retail investor must be sold by an earlier investor. When retail investors finally pour money into the market, they’re handing it to those who are pulling their money out – and end up holding the bag. This is the tail end of the Fed’s “wealth effect.”

And retail investors have been throwing their money into the stock market with gusto. For the first 10 months this year, they handed $172 billion to early investors, the most since 2000. In one week alone, ended October 23, they threw $9.2 billion at US stock funds, the highest since weekly records began in 2007, Bloomberg reported. And early investors took that money and ran.

Total funds allocated to equities hit 57%. There were only two times in the last 20 years when they were higher: in the late 1990s before the bubble imploded, and just before the 2007-2009 financial crisis. Not exactly soothing data points.

But just because it’s a bubble doesn’t mean it’s going to implode anytime soon. It’s during bubbles that you can make the mostest the fastest. The fact that it has already been driven to irrational heights proves that it can be driven to even more irrational heights; there’s no rational limit to irrational heights. The extent to which bubbles can grow has a nasty tendency to surprise those who see them and bet against them. Me included. In October 1999, I was a few months early and lost my shirt.

But this time, it’s different. In 1999, the economy was booming, unemployment was as low as it could get, the employment-population ratio was hitting all-time highs, corporate earnings were growing…. And the S&P 500 rose 19.5%, closing on the high for the year. That was less than three months before the bubble blew up.

This year, the economy is sluggish, unemployment is doggedly high, the employment-population ratio is stuck near multi-decade lows, corporate earnings are stagnating, and revenues have trouble keeping up with inflation. Real wages have declined since 2000, poverty rates are up, the number of people needing assistance to put food on the table has soared…. And the S&P 500 so far this year has jumped 26.5%. With Wall Street clamoring for a Santa rally, people are now envisioning 30% or even 40%. And it’s already up 164% from March 2009.

The near universal giddy bullishness is much broader than it was in 1999. Back then, tech and internet stocks stole the show, and it didn’t take some of them long to double. The bullish fury was concentrated on them. But they were a small part of the whole. Hence the Nasdaq’s meltup, while the S&P 500 “only” rose 19.5%. This time around, the giddy bullishness has infected the broader stock market – the sums involved are much larger. And so are the risks.

And there’s something else that’s different this time: five years of the Fed’s QE and ZIRP. That’s what keeps this bubble inflated for now. The ride to new riches remains intact. And there’s nothing to worry about. Not today, and maybe not tomorrow. And when the day comes, the sell button is just a quarter inch away. For everyone!

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